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ABSTRACT
As developing economies become richer, they seek to contract with the global economy in increasingly complex ways. Dealing with that complexity often implies the renegotiation of contracts. Such recontracting tends to be viewed with concern, particularly by market participants. At the same time, iron-clad commitments to abstain from recontracting are untenable. Sovereign debt experts have long dealt with this dilemma. In this Paper, I argue that the acute trade-off between commitment and flexibility is not unique to sovereign debt. Instead, it is the defining characteristic of an emerging market. Using examples of World Bank guarantees on behalf of sovereign governments to private lenders, exchange rate regimes, and international bond contracts, I highlight the evolution from commitment to flexibility. In their initial interactions with international markets, borrowers typically benefit from strong transaction-specific commitment. However, the goal is to grow out of transactional commitments to achieve commitment through credible institutions. Institutional commitment allows the benefits of flexibility, with the country's "word" acting as the necessary assurance that borrowers will behave responsibly.
I. INTRODUCTION
An Internet search for the definition of an emerging market draws this rich haul:1
* "The market of a developing country with high growth expectations;"2
* "Investments in these markets are usually characterized by a high level of risk and possibility of a high return;"3
* "Emerging markets are extremely volatile, but they offer the potential to share in the early stages of a country's economic growth [with the attendant possibility of higher returns]";4
* "A sector within international stocks made up of developing countries, such as Kenya and China, where economic and political conditions may be more volatile;"5
* "Immature securities market in which there is not a long history of substantial foreign investment;"6 and
* "Markets in securities in newly industrialized countries and in countries in Central and Eastern Europe and elsewhere, in transition from planned economies to free-market economies and in developing countries with capital markets at an early stage of development. Examples are the stock exchanges in Mexico, Thailand and Malaysia."7
The countries listed in these definitions range from Kenya, with a per capita income of $350 in 2000, to Mexico, with a per capita income of just above $5,000.8 What is common across them? The good growth...